For Commodities, This Is The Next Great Depression

While the "sell in 1973, and go away" plan had worked out for some in the commodity space, the destruction of the last decade has only one historical comparison... the middle of The Great Depression.

The 10-year rolling annualized return for commodities is -5.1% - the lowest since 1938...

During the same period Stocks are up 7.3% annualized, Bonds 6.6%, and Cash unchanged. Dip-buying opportunity? Maybe.

UBS thinks so: Tactically we can see a bounce in Q1 before the capitulation starts

Tactically, in September 2015, we actually expected a more significant oversold bounce in commodities from last year’s late September risk bottom into ideally early Q2 2016 before we anticipated more weakness into later 2016. So far, the bounce failed since particularly in the energy complex we saw further weakness into December and the metals have been actually just trading sideways. Nonetheless, according to our Q1 US dollar pullback call, we still see the chance for another rebound attempt in commodities into later Q1, and if so the move can be significant (short covering). Such a rebound would however not change our underlying cyclical roadmap for commodities, and this means that any rebound in Q1 should be limited in price and time before we expect another and potential final capitulation wave to start into H2 2016, where we expect the CCI index to minimum test its 2008 low at 350 to worst case 320.

Commodities... on the way into a multi-year buying opportunity

All in all we are sticking to our last year’s projection and strategy call that commodities are on the way into an important H2 2016/early2017 cyclical bottom. What is missing in our view is the final act in this first bear market. With our expectation to see a final US dollar overshooting into H2 2016, we obviously also see the risk of a final undershooting and capitulation in commodities and related themes into later 2016. Crude oil, and as long as we do not see a break of the 2014 bear trend, we see minimum a test of its 2008 low at around $32 to worst case undershoot to $28 before starting a significant recovery cycle into 2017. For copper we are still more cautious since so far the bear cycle was still relatively mild versus other commodities. In this context, and after a Q1 rebound, we see copper as one of the candidates where we could see a bigger undershooting towards 1.70 to worst case see a test of the 2008 bottom at around 1.20.

On the macro side, another breakdown in commodity prices in later 2016 would very likely trigger a significant spike in cross-asset volatility. It would suggest minimum the speculation about selective defaults in the commodity area and a potential meltdown scenario in high yields, which would very likely filter through into Emerging Market debt. So on the one hand such a scenario would suggest another deflationary impulse on the macro side.

However, with expecting crude oil and other commodities moving into a major cycle bottom (even if a basing process would take a longer time into 2017), and taking into account the historically low basis of commodity prices as well as the base effect in inflation, a 2016/2017 deflationary impulse could be the final deflationary impulse before starting a bigger comeback of inflation towards the end of the decade.

So although tactically, we cannot rule out a volatile basing process in commodities into 2017, at the end of the day we see commodities from a late 2016/early 2017 bottom starting a multi-year bear market rally into the end of the decade before resuming its underlying secular bear into the first half of the next decade. For investors, this would open a time window of 2 to 3 years, where we can see a very significant and sharp bull cycle in commodity prices, and this scenario would obviously also have far reaching consequences for Emerging Markets, where we should see a big comeback starting.